What is Electronic Trading?

Electronic trading refers to buying and selling shares, bonds, foreign currencies, cryptocurrencies, and other financial instruments online. Traditional auction markets and phone trading are gradually being replaced by electronic trading systems that have democratized securities trading and introduced numerous changes. While some exchanges, including the world's largest New York Stock Exchange (NYSE), still use the auction system with specialists physically present on its trading floors, electronic trading platforms, and electronic-only exchanges are rapidly emerging in financial markets claiming to be more efficient.

Speed of transactions, cost saving, risk management, and well-informed decision-making are just some of the benefits of electronic trading. On top of that, it opened up the securities market to far more people across the world, resulting in millions of people trading billions of shares on different platforms.

The best thing is that you don't have to possess any expert knowledge - there are robo-advisors, algorithms, smart order routers, and many other fintech solutions that do the tough job for you. However, it shouldn't be taken lightly because there are pitfalls to beware of. The human element is still of crucial importance and the more you learn about the market and the logic behind it, the more successful you'll be. Let's have a look at how it all works.

Trading Basics

Before we start analyzing electronic trading, maybe we should revise the basics of securities trading in general.

Companies need money in order to operate. So to avoid borrowing from banks, they sell shares of their companies to investors who thus become shareholders. They own pieces of the company and have a limited right to a portion of that company's assets and earnings. Share prices fluctuate depending on the state of the economy, the company's performance, and investors' attitudes. In order to trade shares and other financial instruments, buyers and sellers use either stock exchanges or trade over the counter. The trade is performed via brokers - people licensed to trade securities through the exchange. In the case of electronic trading, online brokers are in charge of this.

Brokerage Firms - Types and How They Work

A brokerage firm acts as an intermediary that brings together buyers and sellers to execute transactions for shares, bonds, options, and other financial instruments. It receives a commission or fee for the job it does. Depending on the level of service it provides and if there is direct contact with human beings rather than computer algorithms, the distinction can be made between full-service (traditional) and discount (online) brokerage.

Full-service brokers offer a range of products and services, including market research and personal financial advisors to provide help and guidance to each client. With online brokers, investors themselves input their buy and sell orders electronically into the broker's automated trading platform.

With electronic trading rapidly improving, traders now have robo-advisors at their disposal to perform transactions. This trading software uses algorithms to automatically execute trading strategies on their client's behalf. As the same securities are offered at different trading venues and in order to make the best possible transaction at a given moment, a smart order routing system is often incorporated into a trading platform. In order to find the best offer, Smart Order Routers analyze the situation at all venues and place orders based on pre-defined rules, configurations, and algorithms.

Where and What Can You Trade?

Financial securities are traded either on an exchange or over the counter (OTC). An exchange is a centralized, regulated market where securities are listed and traded in a standardized and publicly transparent manner. Big companies usually choose exchanges to trade their securities. Some companies can't or don't want to list their financial products on exchanges. They trade over the counter through decentralized dealer networks known as electronic communication networks (ECN). These are completely computerized networks more loosely regulated than exchanges.

There is a number of financial instruments offered on different platforms. Some of them are specialized for trading equities only, or different kinds of derivatives (options, forwards, futures) and foreign currencies. Banks act as market makers for bonds offering them through broker-dealer networks. In the last decade as technology is advancing, cryptocurrencies are becoming more and more popular. There are even platforms specialized for trading crypto pairs, which usually serve the needs of both buy-side and sell-side clients taking part in electronic trading.

Which Electronic Trading Strategy to Choose?

With the rise of electronic trading platforms, various trading strategies appear and traders adopt them to suit their intents. You should adopt a trading strategy that suits your lifestyle, personality, and available resources. It would also depend on the type of financial instruments you plan to trade. A different strategy is applied for example when trading foreign exchange than when trading equities. Some of the most popular trading strategies include news trading strategy, day trading, scalping, and arbitrage.

How to Start Electronic Trading in 2022-2023?

If we tried to simplify things a bit, the most common process of starting and performing electronic trading would include the following steps:

Choose an online broker

In order to get access to exchanges and start to buy and sell, you need to open a brokerage account with one of many firms called broker-dealers which are basically entry points to the stock market. Since different brokers offer different kinds of services and at different prices, you should consider these aspects when choosing a broker:

1. The amount of money you plan to invest - besides general rules regarding the minimum amount investors must possess, some brokers have additional policies;

2. The frequency of your trades - depending on this you should choose either a broker that charges a lower fee per trade or one that doesn't charge a fee for account inactivity;

3. The trading experience you have - if you're an experienced trader, you won't need much assistance from the broker's side, but if you're new to trading, you might benefit from brokers that offer some guidance, market analysis, or licensed broker's advice;

4. Financial instruments you plan to trade with - some online brokers deal only with companies' stocks, while others offer options, futures, bonds, foreign exchange, or cryptocurrencies.

Open a brokerage account

Regardless of what kind of broker you've chosen, these are some of the basic tasks each broker performs:

• Assessing if you meet all the entry criteria to open an account (age, amount of money you possess, etc.),

• Giving access to trading platforms,

• Maintaining the record of the stocks you own,

• Overseeing your trading activities,

• Providing stock quotes.

Perform trading

Now that you've got access to the market through your account, you can check stock quotes to follow the changes in prices. Based on the current situation, you'll decide to buy or sell shares. This is what happens next.

After you make an order to buy shares in a certain company, your broker-dealer transfers the order to the exchange at which the company whose stocks you want to buy trades. The exchange then tries to match your buy order with a sell order from someone else. If there is a match, your trade can be executed. If not, your order will be kept at the exchange until the match appears. When the trade is complete, your broker-dealer is informed and your account is updated - money is withdrawn and new stocks are added to your portfolio.

Apart from your broker-dealer who keeps a record of your stocks, there is a central repository, called the Depository Trust Company (DTC) in the USA, which holds information about the ownership of all stocks at the market. So, this central entity is also informed about your trade and it is in charge of changing the ownership from seller to buyer.

The Technology Behind

The procedure described above seems quite straightforward. However, an extremely complex system difficult to comprehend supports it and makes the whole process possible. It is necessary to make computer systems of all the parties involved to interact. Or, if we know that most trading platforms are also available on different devices such as computers, tablets, and mobile phones, it makes things even more difficult. Or, for example, various tools such as Client Connectivity Hub or Direct Market Access have to be implemented to establish FIX protocol used to transfer trade-related messages in electronic trading. This and many other components comprise a trading platform ecosystem making it very complex, but at the same time easy and helpful for all those involved in electronic trading.